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   401(k)s & IRAs found in Money & Business  :  Investing A   A   A
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Roth IRAs

Roth IRAs are similar to traditional IRAs but with three major differences:
  • After-tax dollars: All Roth IRA contributions are made with after-tax dollars.
  • Tax-free withdrawals: Investments in Roth IRAs grow tax free and are not subject to tax upon withdrawal.
  • No tax deductions: Since Roth IRA contributions are made with after-tax dollars, they don’t qualify for tax deductions.
Roth and Traditional IRAs differ in a few other significant, but more complex, ways. The following table breaks down all the important traits of Roth IRAs, including all the specific features that distinguish Roths from Traditional IRAs.

Key Traits of Roth IRAs

 
Trait
  
Guidelines
Tax benefits
  
You never have to pay taxes on any investment gains or withdrawals if:
  • Your account has been open for at least five years
  • You withdraw at age 59 1/2 or later
  • You use the money to purchase your first home
  • You become disabled or die
Eligibility
  
Plan participants can be any age. Singles with earned income below $99,000 ($156,000 for married joint filers) can make the full contribution plus the “catch-up” contribution, if applicable. Contribution limits decrease for singles with $99,000–114,000 of earned income ($156,000–$166,000 for married joint filers). Singles or couples with income above these ranges can’t contribute to a Roth IRA.
Vesting
  
All contributions vest immediately.
Enrollment deadlines
  
A Roth IRA for a given year must be set up by April 15 of the next year. For example, you have until April 15, 2009, to set up a Roth IRA for 2008.
Contribution deadlines
  
All contributions to an IRA for a given year must be made by April 15 of the next year. For example, you have until April 15, 2009, to make all of your contributions to an IRA for 2008.
Contribution limits
  
Up to $5,000 per year or, if you’re age 50 or older, up to $6,000. Starting in 2009, these limits will increase incrementally depending on the inflation rate.
Contribution sources
  
Earned income (salary, commissions, other work-related sources, alimony).
Withdrawal penalties
  
Since Roth contributions are made with after-tax dollars and don’t qualify for tax deductions, no penalty applies to early withdrawals equal to the amount of your original contributions. Any gains realized by early withdrawals are subject to income tax and a 10% penalty, however.
Transfers
  
Most plans can be transferred to other Roth (after-tax) retirement plans.
Borrowing
  
Loans from Roth IRA accounts are not permitted.
Beneficiaries
  
You can designate primary and contingent beneficiaries. Roth IRAs are the only IRAs that can be passed on income tax–free to beneficiaries.
Required minimum distributions
  
Roth IRAs have no required minimum distributions.
Fees and minimums
  
Annual fees range from $0–50. Minimums range from $0–25, depending on the plan provider.
 

Traditional IRAs vs. Roth IRAs

Though Roth IRAs permit tax-free growth and withdrawals, they’re not necessarily the best choice for everyone. To help decide between any tax-deductible and tax-deferred plan, such as a Traditional IRA and its tax-free Roth version, consider your current tax bracket and your expected tax bracket at the time you plan to withdraw the funds:
  • If you expect your tax bracket at withdrawal to be roughly the same as, or higher than, your current tax rate, you should probably choose the Roth version of the plan.
  • If you expect your tax bracket at withdrawal to be significantly lower than your current tax bracket, you should probably choose the standard tax-deductible/tax-deferred version of the plan.
Though helpful as a general guideline, this rule of thumb doesn’t apply to all situations. Even if you expect your tax bracket at withdrawal to be much lower than your current rate, you might still consider a Roth for these reasons:
  • Estate planning: Roth IRAs pass to beneficiaries without incurring a federal income tax liability, though they may be subject to estate taxes.
  • Control of assets after retirement: Only Roth IRAs allow you to retain complete control over your retirement account assets past age 70 1/2, with no required minimum distributions.
  • High income: Even if you earn too much to qualify for a Traditional IRA deduction, you may still qualify to contribute to a tax-free Roth IRA.

Converting a Traditional IRA to a Roth IRA

The IRS allows you to convert Traditional IRAs to Roth IRAs with no penalties, assuming you meet certain income conditions. If you have an adjusted gross income below $100,000 (single or married filing jointly), you can convert all or part of your Traditional IRA assets to a Roth IRA.

One catch applies: when you do the conversion, you’ll need to pay taxes on any gains in the Traditional IRA, even if you’re simply moving those assets into your new Roth IRA.
 
 
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